In 1990, there were about 600 hedge funds worldwide with assets of approximately $38 billion. In 2003, the Hedge Fund industry was estimated to be a $875 billion in size and growing at about 20% per year with approximately 8350 active hedge funds.

1. Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls, options, futures, etc.)
2. Hedge funds vary enormously in terms of investment returns, volatility and risk. Many, but not all, hedge fund strategies tend to hedge against downturns in the markets being traded.
3. Many hedge funds have the ability to deliver non-market correlated returns.
4. Many hedge funds have as an objective consistency of returns and capital preservation rather than magnitude of returns. Most Hedge Fund strategies do not focus on huge returns, but should be viewed as a diversification instrument for your portfolio.
5. Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns.
6. Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage.
7. Hedge funds benefit by heavily weighting hedge fund managers’ remuneration towards performance incentives, this is why you see the best brains in the investment business starting Hedge Funds. In addition, hedge fund managers usually have their own money invested in their fund.

One popular misconception is that all hedge funds are volatile -- that they all use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities, and gold, while using lots of leverage. In reality, less than 5% of hedge funds are global macro funds or other very high risk funds. Most hedge funds use derivatives only for hedging or don't use derivatives at all, and many use no leverage.

1. Many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets.
2. Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility and increases returns.
3. Huge variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice of hedge fund strategies to meet their investment objectives.
4. Academic research proves hedge funds have higher returns and lower overall risk than traditional investment funds.
5. Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from markets.
6. Adding hedge funds to an investment portfolio provides diversification not otherwise available in traditional investing.

1. Includes a variety of investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. Many hedge fund strategies seek to reduce market risk specifically by shorting equities or through the use of derivatives.
2. Performance of many hedge fund strategies, particularly relative value strategies, is not dependent on the direction of the bond or equity markets -- unlike conventional equity or mutual funds (unit trusts), which are generally 100% exposed to market risk.
3. Many hedge fund strategies, particularly arbitrage and systemic strategies, are limited as to how much capital they can successfully employ before returns diminish. As a result, many successful hedge fund managers limit the amount of capital they will accept.
4. Their returns over a sustained period of time have outperformed standard equity and bond indexes with less volatility and less risk of loss than equities. The Risk Adjusted Returns of Hedge Funds are generally much better then mutual funds because of their inherent focus on RAR, and other quantitative financial factors.

1. Selling short - selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their price will drop.
2. Using arbitrage - seeking to exploit pricing inefficiencies between related securities - for example, can be long convertible bonds and short the underlying issuers equity.
3. Trading options or derivatives - contracts whose values are based on the performance of any underlying financial asset, index or other investment.
4. Investing in anticipation of a specific event - merger transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.
5. Investing in deeply discounted securities - of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.
6. Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets

Aggressive Growth: Invests in equities expected to experience acceleration in growth of earnings per share, in many cases these are small cap stocks. Generally high P/E ratios, low or no dividends; the selected smaller and micro cap stocks which are expected to experience rapid growth. Includes sector specialist funds such as technology, banking, or biotechnology. Hedges by shorting equities where earnings disappointment is expected or by shorting stock indexes. The funds tend to be "long-biased." Expected Volatility: High

Distressed Securities: Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or reorganization. Profits from the market's lack of understanding of the true value of the deeply discounted securities (or fear) and because the majority of institutional investors cannot own below investment grade securities. (This type selling pressure also helps create the deep discount.) The results are generally not dependent on the direction of the markets. Expected Volatility: Low - Moderate

Emerging Markets: Invests in equity or debt of emerging (less mature) markets that tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available, although some situations can be partially hedged via U.S. Treasury futures and currency markets. Expected Volatility: High to Very High

Income: Invests with primary focus on yield or current income rather than solely on capital gains. May utilize leverage to buy bonds and sometimes fixed income derivatives in order to profit from principal appreciation and interest income. The key focus is to use the leverage and derivatives to increase the income returns of the utilized instruments with a lower degree of risk. Expected Volatility: Low

Macro: Sometimes labelled "Global Macro". Aims to profit from changes in global economies, typically brought about by shifts in government policy that impact interest rates, in turn affecting currency, stock, and bond markets. Many of these funds participate in all major markets -- equities, bonds, currencies and commodities. Uses leverage and derivatives to accentuate the impact of market moves. Utilizes hedging, but the leveraged directional investments tend to make the largest impact on performance. Most funds invest globally in both developed and emerging markets. A number of these funds use large leverage and place huge directional bets. Many currency funds are considered "Macro" funds. Expected Volatility: High to Very High

Market Neutral - Arbitrage: Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. For example, can be long convertible bonds and short the underlying issuers equity. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. These relative value strategies include fixed income arbitrage, mortgage backed securities, capital structure arbitrage, and closed-end fund arbitrage. The fixed income arbitrageur aims to profit from price anomalies between related interest rate securities. Most managers trade globally with a goal of generating steady returns with low volatility. This sub-category includes interest rate swap arbitrage, US and non-US government bond arbitrage, forward yield curve arbitrage, and mortgage-backed securities arbitrage. Some of these funds mirror the neutral strategies first employed by Alfred Jones. Income Arbitrage Managers are normally very "quantitative finance" focused and regularly crunch numbers/stats to determine the best income arbitrage situations. Expected Volatility: Low

Market Neutral - Securities Hedging: Invests equally in long and short equity portfolios generally in the same sectors of the market. Market risk is greatly reduced, but effective stock picking is key to obtaining meaningful results. This investment strategy is designed to exploit equity market inefficiencies and usually involves being simultaneously long and short matched equity portfolios of the same size within a country. Market neutral portfolios are designed to be either beta or currency neutral, or both. Well-designed portfolios typically control for industry, sector, market capitalization, and other exposures. Leverage is often applied to enhance returns. Usually low or no correlation to the market. Sometimes uses market index futures to hedge out systematic (market) risk. A number of the Market Neutral Security Funds are currently more directional in nature and attempt to capture trends that last several months. Expected Volatility: Low to Moderate

Market Timing: Allocates assets among different asset classes depending on the manager's view of the market outlook. The portfolio may swing widely between asset classes. Unpredictability of market movements and the difficulty of timing entry and exit from markets increase the volatility of this strategy. Expected Volatility: High

Opportunistic: Investment theme changes from strategy to strategy as opportunities arise to profit from events such as IPOs, sudden price changes often caused by an interim earnings disappointment, hostile bids, and other "event-driven" opportunities. May utilize several of these investing styles at a given time and is not restricted to any particular investment approach or asset class. The inside industry humor for this style is "Get a dart board and select what you plan to buy today." Some managers of these opportunistic funds are all over the map in the situations they pursue. Expected Volatility: Moderate to High

Event-Driven: A more focused version of "Opportunistic". This strategy is defined as equity-oriented investing designed to capture price movement generated by an anticipated corporate event. There are four popular sub-categories in event-driven strategies: risk arbitrage, distressed securities, Regulation D and high yield investing:

• Risk Arbitrage: Specialists invest simultaneously in long and short positions in both companies involved in a merger or acquisition. Risk arbitrageurs are typically long the stock of the company being acquired and short the stock of the acquirer. The principal risk is deal risk, should the deal fail to close. Expected Volatility: Moderate to High
• Distressed Securities: Fund managers invest in the debt, equity or trade claims of companies in financial distress and generally bankruptcy. The securities of companies in need of legal action or restructuring to revive financial stability typically trade at substantial discounts to par value and thereby attract investments when managers perceive a turn-around will materialize. In many of these situations, the fund managers are directly involved in private deals regarding financing. Expected Volatility: Moderate to High
• Regulation D, or Reg. D: This subset refers to investments in micro and small capitalization public companies that are raising money in private capital markets. Investments usually take the form of a convertible security with an exercise price that floats or is subject to a look-back provision that insulates the investor from a decline in the price of the underlying stock. Expected Volatility: Moderate to High
• High Yield: Often called junk bonds, this subset refers to investing in low-graded fixed-income securities of companies that show significant upside potential. Managers generally buy and hold high yield debt. Many sites often list "High Yield" as a separate strategy. Expected Volatility: Moderate

Systematic: Investment approach is diversified by employing various strategies simultaneously to realize short- and long-term gains. Other strategies may include systems trading such as trend following and various diversified technical strategies. This style of investing allows the manager to overweight or underweight different strategies to best capitalize on current investment opportunities. Many "Managed Futures" funds use Systematic approaches utilizing technical analysis. Expected Volatility: Variable

Short Selling: Sells securities short in anticipation of being able to re-buy them at a future date at a lower price due to the manager's assessment of the overvaluation of the securities, or the market, or in anticipation of earnings disappointments often due to accounting irregularities, new competition, change of management, etc. Dedicated short sellers (strictly shorted only) were once a robust category of hedge funds before the long bull market in the 1990s rendered the strategy difficult to implement. A new category, "short biased", has emerged. The intent of this strategy is to maintain net short as opposed to pure short exposure. The short bias of a manager's portfolio must be constantly greater than zero to be classified in this category. Many investors use this type of hedge fund to offset long-only portfolios and by those who feel the market is approaching a bearish cycle. Expected Volatility: High to Very High

Special Situations: Invests in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the company. May also utilize derivatives to leverage returns and to hedge out interest rate and/or market risk. Results generally not dependent on direction of market. Some Special Situation Funds may be considered "Event Driven". Expected Volatility: Moderate to High

Value: Invests in securities perceived to be selling at deep discounts to their intrinsic or potential worth. "Try to be like Warren Buffet." Such securities may be out of favor by analysts or in special situations such as management change. Long-term holding are often required until the value is recognized by the market for these funds. Expected Volatility: Low - Moderate

Convertible Arbitrage: This strategy is identified by hedge investing in the convertible securities of a company. A typical investment is to be long the convertible bond and short the common stock of the same company. Positions are designed to generate profits from the fixed income security as well as the short sale of stock, while protecting principal from market moves. Expected Volatility: Moderate

Long/Short Equity : This directional strategy involves equity-oriented investing on both the long and short sides of the market. The objective is not to be market neutral. Managers have the ability to shift from value to growth, from small to medium to large capitalization stocks, and from a net long position to a net short position. Managers may use futures and options to hedge. The focus may be regional, such as long/short US or European equity, or sector specific, such as long and short technology or healthcare stocks. Long/short equity funds tend to build and hold portfolios that are substantially more concentrated than those of traditional stock funds. Expected Volatility: Moderate to High

Managed Futures: This strategy invests in listed financial and commodity futures markets and currency markets around the world. The managers are usually referred to as Commodity Trading Advisors, or CTAs. Trading disciplines are generally systematic (mechanical systems) or discretionary. Systematic traders tend to use price and market specific information (often technical) to make trading decisions, while discretionary managers use a judgmental approach. Most Managed Future Funds only accept limited amounts of capital to enable the manager to be successful in deploying their strategies. One example of small Managed Futures fund is http://www.schindlertrading.com Notice the large volatility in the monthly results which are an expected part of the systematic trading strategy for this fund. Expected Volatility: Moderate to Very High

1. A diversified portfolio of generally uncorrelated hedge funds.
2. May be widely diversified, or sector or geographically focused.
3. Seeks to deliver more consistent returns than stock portfolios, mutual funds, unit trusts or individual hedge funds.
4. Preferred investment of choice for many pension funds, endowments, insurance companies, private banks and high-net-worth families and individuals.
5. Provides access to a broad range of investment styles, strategies and hedge fund managers for one easy-to-administer investment.
6. Provides more predictable returns than traditional investment funds.
7. Provides effective diversification for investment portfolios.

1. "An individual with at least a $200,000 annual income or a net worth of at least $1,000,000."
2. Or, "A corporation, partnership, LLC, business trust or tax-exempt organization not formed for the purpose of investing in hedge funds and with total assets in excess of $5,000,000."

The Management Fee is charged to cover the fixed costs (regulatory, auditing, etc.)of the Hedge Fund. This fee is charged irregardless if the performance of the fund is up or down. This fee is usually tacked on (pro-rated) on a monthly or quarterly basis

Hedge funds also get a 20% cut of any trading profits, a reward known as the "incentive fee", "performance fee", or "carry." This is on top of the annual management fees.

Hedge fund managers are rewarded primarily in proportion to the profitability of the fund's investments (typically 20% of profits). Many times a "hurdle" rate of return must be achieved or any previous losses recouped before the performance fee is paid. This performance based fee structure gives the manager great incentive to achieve maximum returns within the risk profile of the fund.

What is the "High Water Mark" in regards to Performance Fees? The usual hedge fund contract at least protects you from getting whipsawed by a manager who makes money one year, loses it the next and makes it back the third year. The "high-water mark" provision works as follows: If the manager gets an incentive fee for taking the fund up X%, he doesn't get additional incentive fees until the fund tops a cumulative X% return. Say the manager doubles a $100 million pot to $200 million, pocketing a $20 million incentive. The next year the $180 million pot shrinks to $100 million. Additional incentive fees are due only to the extent the manager pushes the fund above $200 million.

In Reality, what happens to funds that have large draw-downs? Hedge Funds that have large draw-downs of 30% or greater normally close up shop and distribute the remaining funds back to the investors. Why is this done? - It is because the manager gets most of his income from the performance fees, and it will take a long time to get above the high water mark again which will allow the manager to be awarded performance fees again. Many of the managers of funds with large draw-downs will simply fold up shop, and walk down the street & open a new fund so they can start from scratch. Due to this, it is important to get the complete history of the Hedge Fund manager you are selecting. Ask not only for information on the current fund, but the history of all previous funds that were managed. You don't want to select a manager that blew out his last 3 funds.

As a side note, managing a new fund and having previous (successful) fund is not always a negative situation. Many managers change funds simply because they desire to focus on a different investing style for a new Hedge Fund that is different then their previous profitable fund.

Also note that some funds such as "Managed Futures", "Systematic", and others expect large draw-downs as part of their strategy, and 50% draw-down is not considered unusual but simply an accepted part of their strategy. Different funds have various volatility profiles, an investor must understand the risk expectations of a fund before placing money in it (as well as the over-all needs of your portfolio).

Traditionally, since US hedge funds are organized as Limited Partnerships (private investment vehicles), they have existed with relatively few regulatory requirements. In fact, a US-domiciled fund does not need to register with the SEC if it conforms to one the following:

Regulation D Exemption of the Securities Act of 1933 : The Securities Act of 1933 states that securities sales in the United States must be either registered or exempt. A security (Hedge Fund) need not be registered if it satisfies the Regulation D Exemption, which states that:

All but 35 holders of such securities are "accredited investors,"as defined: a person with net worth in excess of $1mm or with income of $200,000 ($300,000 joint income with a spouse now) in each of the prior two years with an expectation of earning the same in the current year.

And, the securities are privately placed (broad marketing is not allowed).

Does the above regulation mean that a Fund can have up to 35 "non-accredited investors"? Yes, but most funds will not accept non-accredited investors because it increases the required paperwork. Normally there is a total limit of 100 investors per fund. Most fund managers prefer that all investors be accredited to avoid potential regulatory hassles.

What is the Section 3(c)(1) from the Investment Company Act of 1940? This is the section that allows a fund to have fewer than 100 investors, of whom up to 35 can be non-accredited investors.

Can you provide some more detail on 3(c)1 or 3(c)7 Exclusion of Investment Company Act of 1940 A hedge fund manager is exempt from the provisions of the 1940 Act if the fund can remain outside of the statutory meaning of an investment company subject to registration. These exclusions fall primarily under two sections of the Act:

3(c)1: if a fund has under 100 beneficial owners and they are qualified purchasers, it need not register as an investment company.

3(c)7: if a fund has 500 "super-qualified" (higher net worth and income amounts), then it need not register as an investment company. Usually applies to institutions only (but not always).

Both 3(c)1 and 3(c)7 also stipulate that the fund is neither making nor intending to make a public offering. There is no exemption if the Investment Advisor holds itself out to the public as an Investment Advisor.

As a follow-up, the Investment Company Act was amended in 1996, requiring registration if the adviser has more than $30 million under management and has more than 14 clients. Additionally, federal registration is not allowed if the manager has less than $25 million under management. The SEC is currently reviewing the requirements and regulations for Hedge Funds, and further updates are expected.

If a manager strictly trades commodities or futures in a fund then he will probably need to set up a Commodities Pool that is registered with the National Futures Association (NFA). The Commodity Futures Trading Commission has delegated most of its day-to-day regulatory duties to the NFA. There are a number of additional regulations associated with Commodity Pools, but they mirror the requirements for Hedge Funds.

Most Hedge Funds focus on the bond and equity markets, while using options & futures for hedging. Most Hedge Fund managers are licensed brokers that have passed the Series 7 & 63 exams, and many are registered investment advisors. The SEC provides oversight for the Hedge Fund market. Currently the SEC is looking at increasing the regulation and reporting requirements for these funds, as well as the net worth requirements to be considered an "accredited investor".

• IASG Rankings - Primarily CTAs (Futures) - very complete
• Barclay Searchable Database
• Cogent Searcable Database - must register
• Morgan Stanley Hedge Fund Indexes and Information
• Hedge Index - Provides index information bases on Hedge Fund strategies
• Hedge World - Includes a searchable database (must register)
• Van Hedge - Includes a searchable database (must register)
• AutumnGold - Includes Database (must register)
• eHedge.de - Incloudes searchable database (must register)
• Investorforce - News and Database
• Hedge Fund News
• The Hedge Fund Association - non-profit Industry forum